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  News Analysis: Rescue Puts Fed Credibility on the Line

News Analysis Rescue Puts Fed Credibility on the Line

By Edmund L. Andrews

Part 2: US Taxpayers Could End up Footing the Bill

Several measures of risk aversion receded slightly. Spreads between the higher yields that investors demand for debt securities compared with those for safer Treasury bonds declined slightly. So did prices for credit default swaps, which amount to insurance premiums paid to protect bondholders in the case of a default.

“The early evidence is that the Fed is starting to get some traction,” said Michael Darda, chief economist at MKM Partners, a hedge fund and trading firm in Greenwich, Conn. Mr. Darda, who has been critical of the Fed for being inattentive to inflation pressures, said he nonetheless sympathized with policy makers’ fears about a financial market crisis.

“This is really a very ugly situation for the Fed to be in,” Mr. Darda said. “They’re making a calculation about what is the greater evil, and they’ve made a decision that letting the credit crisis exhaust itself is too big a risk.”

Analysts caution that for all its might, the Federal Reserve and its loan program face limits unless officials decide to start printing more money to pay for the rescue.

At the moment, the central bank has committed cash and Treasury bonds that are in its own reserves, totaling about $800 billion. But having agreed to provide at least $400 billion in short-term loans, and probably more, it is pledging a big share of its resources to the rescue.

“The Fed is now running on less than a half tank of gas,” Laurence H. Meyer, a forecaster at Macroeconomic Advisers and a former Fed governor, wrote in a note to clients. “The Fed seems to be running out of room for these types of measures.”

Officials at the central bank brushed aside such concerns, noting that many of the loans would be limited to 28 days and that the longest-term loans have to be repaid within 90 days. Fed officials also say that the combined rescue effort is not as big as the sum of the individual loan programs implies, because some institutions will simply shift from an earlier program that is less convenient to the newest one announced on Sunday.

If the rescue effort fails, taxpayers could indirectly wind up having to assume part of the cost. Tax revenue does not pay for the Federal Reserve’s operations, including the rescue effort, because the Fed earns income from its trading operations.

But the Fed does pay the Treasury a regular stream of money every year out of its trading profits, lowering the amount it needs to borrow from outsiders. If the new borrowers on Wall Street are unable to repay, and if the market value of the securities they pledge as collateral continues to drop, the losses will come out of the Fed’s payments to the Treasury.

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